China economy

China’s economy set to come under pressure as it fights ‘critical battles’

Beijing has identified fighting debt, poverty and pollution as it priorities in 2018, but they are unlikely to be its only challenges, experts say

PUBLISHED : Tuesday, 02 January, 2018, 11:25am
UPDATED : Tuesday, 02 January, 2018, 11:25am

China’s economy begins 2018 facing what its leaders have called three years of “critical battles”.

Those fights to tackle domestic debt, poverty and pollution pose a hat-trick of risks to the world’s second-largest economy even before higher interest rates and trade war threats from the United States are taken into account.

While the nation is starting from a position of strength, with full-year growth in 2017 poised for its first acceleration since 2010, the expansion is expected to slow in 2018.

As a result, the government of President Xi Jinping is signalling that it is sanguine about more modest economic performance, if progress on the top risk – financial fragility – can be made.

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“Significant economic imbalances continue to create downside risk to the outlook for 2018,” Rajiv Biswas, chief Asia-Pacific economist at IHS Markit in Singapore, said. “Risks to the Chinese economy will remain among the key risks to the global growth outlook in 2018, with the Asia-Pacific region particularly vulnerable to the shock waves from a slowdown.”

Those waves have not materialised, and in fact economic activity is holding up. The official manufacturing purchasing managers index was 51.6 in December, signalling improving conditions. New export orders also climbed to a six month high, according to a sub-index.

Still, forecasters expect expansion to slow to 6.5 per cent – the lowest rate since 1990 – this year. The following are among areas they flag as having the potential to trip up economic growth or spur market turbulence.

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Financial risks

The Communist Party recently renewed its pledge to prevent and control financial risk, calling it a pivotal challenge for the next three years. As the financial system opens further to foreign firms, a debt-to-GDP ratio that is heading towards more than 320 per cent by 2022 stands as the main danger.

“Even its own propaganda machine admits that this is such a serious problem that Beijing doesn’t expect there to be any solution in anything less than three years,” Pauline Loong, managing director of research firm Asia-Analytica in Hong Kong, said.

“Financial instability is the core problem. Solve that and you ease pressure on capital outflows, complications from deleveraging, weaknesses in smaller banks.”

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Construction slowdown

The tightening of financial and environmental regulations to help curb debt may cause tremors in 2018 that slowed housing and infrastructure construction, Frederic Neumann, co-head of Asian economics research at HSBC Holdings in Hong Kong, said.

“A sharper than expected slowdown in construction could weigh on broader activity with emerging sectors not yet vigorous enough to provide a sufficient cushion,” he said.

“The biggest fault line running through the Chinese economy is the construction sector.”

US President Donald Trump’s recent national security strategy speech was a “tee up” for a turn towards protectionism, David Loevinger, a former China specialist at the US Treasury Department, said.

“On the menu for 2018: lots of red meat for the base, and that means bashing imports,” said Loevinger, who is now an analyst at TCW Group in Los Angeles. “Since nationalistic populism is as irresistible in China, Chinese politicians will feel forced to retaliate.”

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Fed, tax

If the US Federal Reserve raised interest rates more than markets expect and tax cuts built on underlying 3.2 per cent growth, the dollar may get a second wind that put the yuan and capital outflows under pressure again, said George Magnus, an associate at Oxford University’s China Centre and former adviser at UBS Group AG.

“If the Fed starts hiking and the dollar goes on a bull run, that would cause big problems,” said Christopher Balding, an associate professor at the HSBC School of Business at Peking University in Shenzhen.

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North Korea

Should tension between the US and North Korea escalate into a more significant confrontation, there would be profound and far-reaching consequences not just for China’s economy but the entire Asia-Pacific region, said Zhu Ning, deputy director of the National Institute of Financial Research at Tsinghua University in Beijing.